A major review of retirement income,
chaired Professor David Blake of the Pensions’ Institute at Cass Business
School, has found that millions of pensioners are exposed to risks that they do
not understand and should not be expected to manage themselves.

The Independent Review of
Retirement Income (IRRI), recommends that a national consensus on the issue is needed
if the Government’s ‘freedom and choice’ pension reforms are to be a success. The report also makes recommendations on how
best to boost defined contribution (DC) savers’ retirement incomes.

The IRRI was set up by the
Official Opposition to review the pensions market in the UK following the
introduction of the coalition government’s pension reforms in 2014.

Professor David Blake, Chair of the IRRI and Director of the
Pensions Institute at Cass Business School, comments:

“A great deal of effort will now have to go into re-establishing
what a good pension scheme is. This will
need a commonly agreed national narrative. Without this, people’s aversion to
annuitisation combined with their willingness to pay highly for both
flexibility and guarantees could leave them worse off than if they purchased an
annuity to begin with. This is a significant challenge. But it is one that is
well worth the effort because, as the Pensions Minister, Ros Altmann, says:
“pensions are precious”’.

Key findings from the IRRI include:

Pension savers need significantly more
help - There are significant risks involved in the generation of
retirement income from pension savings, such as investment risk, inflation risk
and longevity risk. Following ‘freedom and choice’, these risks are borne
directly by DC scheme members. Unfortunately, many people do not understand
these risks, even with improved financial education. Some risks have to be
experienced before they can be genuinely understood, by which point it may be
too late to reverse the damage caused by poorly informed decisions.

Auto-enrolment
inertia v decumulation choice - If a large group of people
cannot understand the risks they face, they should not be expected to manage
these themselves. Instead, if there are well designed and regulated schemes
which use retirement income products that manage these risks in the most
efficient and cost-effective way, it might be possible to nudge or default
savers towards one of these schemes. Can we build on the lessons of
auto-enrolment by having a well-designed default decumulation process at
retirement?

Appropriate products need
to be developed - A good product for
delivering retirement income needs to offer a combination of features,
including: accessibility (the flexibility to withdraw funds when needed);
inflation protection either directly or via investment performance, with
minimal involvement by individuals who do not want to manage investment risk;
and longevity insurance. No single product meets all these requirements, but a
combination of drawdown and a deferred (inflation-linked) annuity does, for
example. So a well-designed retirement income programme will have to involve a
combination of products.

There is a need for ‘safe
harbour retirement income plans’ - This
would involve a simple decision tree with a limited set of pathways. This would
allow people to get the best combination of retirement income products for
them, given their assets, liabilities, health status, family circumstances, tax
position, and risk appetite and capacity. The plan would be self-started
following a guidance or advice surgery, and the plan member has the right to
opt out until the point at which the longevity insurance kicks in. The plan
would also deal with one of the important lessons from behavioural economics
which is that too much choice is a bad thing. There are now far too many poorly
designed and expensive choices of product available at retirement.

We need a ‘national narrative’ - Making
decisions about retirement income are the hardest financial decisions people
ever have to make, because the risks in pensions are so poorly understood.
Getting it right requires a national narrative about what pensions are for.
Everyone in Parliament – whatever their political affiliation – and industry
has to sign up to this narrative – just as they did with auto-enrolment.

Making your money last - The
unifying thread that runs through a funded pension scheme is the requirement to
annuitise enough pension wealth, at the appropriate age, to provide an adequate
lifelong income in retirement when combined with the state pension – which is
the rationale for establishing a private-sector pension scheme in the first
place. It is this requirement which makes a funded pension scheme different
from any other type of savings scheme.

When
annuitisation becomes optional, that unifying thread is no longer present and
there is a real danger that the pension system begins to unravel. At best, it
just becomes a tax-favoured arrangement for operating a multi-purpose spending
pot – once the money has been spent for one purpose, it cannot be spent on
another.

At worst, it becomes a honey pot for thieves and other opportunists. Lying
between these extremes are millions of people now in control of their pension
pot and who will be trying to do the best for themselves and their families.
But for anyone who understands the risks involved in retirement income
provision, it is clear that many of these people will find themselves in the
same kind of control as a yachtsman in the middle of the Atlantic in a force
nine gale.

Further detail on each of the key findings is available to view in
the full press release.

The Review team are members of
the Pensions Institute, an independent academic research centre, based at Cass
Business School. They were asked to consider
how to support a pensions market that works for all, retaining flexibility and
choice on how savings are accessed and drawn down, while ensuring all savers,
including those on low and modest incomes, are able to secure a decent and
reliable retirement income. Their
research, conducted over two years, involved consultation with key industry
players and incorporates the findings of a hundred surveys and studies dealing
with the reforms.

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